After January 1, 2020 Are Subcontractors Going to Be Treated as Your Employees?

Important steps to take to ensure your subcontractors are not considered to be your employees as of January 1, 2020
The Impact of AB 5 on Contractor – Subcontractor Relationships.

By

William C. Last, Jr. & Patrick J. Whitehorn

As many of you know, the California Legislature passed Assembly Bill 5 (“AB 5”) which was signed by the Governor on September 18, 2019. AB 5 significantly changes California law with regard to when an individual performing work must be treated as an employee and when they can be treated as an independent contractor. While this law was directed mainly at the Gig Economy (Uber, Lift, Door Dash, etc.) it will have profound effects on the construction industry. This law takes effect on January 1, 2020.

AB 5 adopts a new framework, the “ABC” test, first established by Dynamex v. Superior Court (2018) 4 Cal. 5th 903 for determining when an individual must be considered an employee rather than an independent contractor. This new framework supplants the prior test for determining whether an individual was an employee or an independent contractor, based largely on issues of control over the work that was established in S. G. Borello & Sons, Inc. v. Department of Industrial Relations. (1989) 48 Cal. 3d 341. The new “ABC” test under Dynamex and AB 5 makes an individual who provides labor or services in exchange for payment an employee unless the hiring entity can meet all three of the following conditions:

  • A. The person is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.
  • B. The person performs work that is outside the usual course of the hiring entity’s business.
  • C. The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

AB 5 contains an express exemption from this test for the construction industry. Under this exemption a subcontractor will not be considered your employee, and the “ABC” test established by Dynamex and codified by AB 5 will not apply if seven (7) conditions are met. When these conditions are met, the prior rules under Cal. Labor Code 2750.5 and Borello apply, and there will be no change the relationship between a contractor a subcontractor.

As of January 1, 2020, in order to ensure that an individual performing work pursuant to a subcontract is not required to be treated by you as an employee, and may continue to be treated as an independent contractor, you will need to satisfy all of the following requirements:

  1. Your subcontract must be in writing.
  2. The subcontractor must be licensed by the Contractors State License Board and the subcontractor’s scope of work must be within the scope of that license.
  3. If the subcontractor is domiciled in a jurisdiction that requires the subcontractor to have a business license or business tax registration, the subcontractor must have the required business license or business tax registration. Your subcontracts should require the Subcontractor provide you with proof that they possess the required business license or business tax registration.
  4. The subcontractor must maintain a business location/address that is separate from your business or work location of the contractor.
  5. The subcontractor must have the authority to hire and to fire other persons to provide or to assist in providing the services for which you are subcontracting.
  6. The subcontractor must assume financial responsibility for errors or omissions in the labor or services it provides, as evidenced by insurance, legally authorized indemnity obligations, performance bonds, or warranties relating to the labor or services being provided. Your written subcontracts should at a minimum include an indemnity obligation and require that subcontractors provide you with copies of their certificates of insurance.
  7. The subcontractor must be customarily engaged in an independently established business of the same nature as that involved in the work performed.

When each of these criteria are met, your subcontractors will continue to be treated as independent contractors and not as employees. It is very important that you maintain this distinction. If you fail to meet these 7 criteria for any of your subcontractors, they will be considered to be your employees, and if that happens and you are not carrying sufficient workers compensation insurance to cover these “employees” you can be subject to retroactive license suspension and possible disgorgement penalties.